Demand Debt Research Articles

Preventing runs under sequential revelation of liquidity needs

I examine whether a financial intermediary issuing demandable debt can eliminate run equilibria by properly adjusting or restricting payouts in case of heavy redemptions. I study a model where investors learn their own liquidity needs over time and may withdraw preemptively before knowing their future liquidity needs. The difficulty in preventing runs is that, on the one hand, imposing temporary restrictions on withdrawals in case of excess redemptions may be necessary to avoid costly asset liquidations, while on the other hand, it is precisely the prospect of such restrictions on withdrawals that may induce investors to withdraw preemptively. Implementation of the first-best allocation without a run equilibrium is possible if and only if either liquidation costs are not too high or investors are not too risk averse.

Do Depositors Respond to Banks’ Social Performance?

ABSTRACT We study whether and how banks’ social performance affects depositors, who hold demandable debt with pervasive government protection. Exploiting the regulatory releases of bank performance ratings for community development and a difference-in-differences design, we find a decline in deposit growth after the release of negative bank social performance. In addition, deposits that are impacted by the negative events flow to nearby banks with high social performance. Further analyses find that the results hold similarly among insured and uninsured deposits and are primarily driven by banks with a large proportion of deposits from high-trust and pro-social counties, and in poor information environments. Overall, we contribute to the literature by documenting the importance of social performance to nonshareholder stakeholders and providing implications for bank stability. JEL Classifications: D82; G21; M14.

THE PUBLIC DEBT PHENOMENON IN FISCAL SUSTAINABILITY, AND FINANCIAL DEVIATIONS IN SELECTED OECD COUNTRIES

In this study, we attempt to put forth the sustainability phenomenon, an empirical that occurs a significant fiscal impact on developing countries, which aim to reach the desired economic growth levels. Sustainability of public fiscal balances, especially in terms of debt policies, refers to a structural impact mechanism that means paying debts without default and restructuring them without risk in a period when the payment and redemption deadlines have come, especially in terms of external debts. This mechanism of influence is also expressed in the restructuring of a financial process, which can be expressed in different values, especially in developing countries, and whether the defaulted public liabilities refer to the later debt phenomenon. In this respect, public fiscal sustainability means that the real level of future primary surpluses is equal to the current real value of the public debt at a fundamental level. In our analytical study, the four countries were taken as the basis and the analytical values of these four countries in the financial balances were determined as emerging economies on the basis of these selected countries as Turkey, Poland, Chile, and Mexico. Besides, based on debts and public deficits, this fact also means a sustainable fiscal structure that can emphasize all kinds of debt phenomena at different levels, especially local governments, and the central government throughout the country. In addition, a debt obligation covering the entire public sphere also expresses sustainability in the narrow sense, representing the central government budget, which is essential in terms of sustainable budget balances. On the other hand, the sustainability of debts in developing countries where foreign public debt is in question, especially the public debt of central banks, can also lead to unexpected financial weakness and vulnerabilities. The policies as public borrowing instruments can create uncertainty about the level of financial-institutional impact in terms of future principal and interest payments and negatively affect fiscal policies sustainability. In this context, the acceptability of this fiscal process regarding the receivables of all institutions such as private bondholders, banks, and the World Bank is accepted as the sustainability of the debts in an ongoing process with mutually positive financial formations. When countries demand debt from financial markets, they have to maintain their fiscal sustainability regarding whether they should retake financial risks, especially in developing countries. This approach, which can also be expressed as the stability of debts, also puts forward a position identical to the expectations of stable ground for developing economic growth potential and financial infrastructure.

Money runs

In this paper, we develop a model that links the funding role of bank debt in the primary market to its circulation in the secondary market. We uncover a new rationale for why banks do what they do. Banks choose to fund themselves with demandable debt because it commands a high price, even though doing so exposes them to “money runs” resulting from its failure to circulate. In the model, banks endogenously perform the essential functions of real-world banks: they transform liquidity, transform maturity, pool assets, and have dispersed depositors. We show novel effects of suspension of convertibility.

Cheap but flighty: A theory of safety-seeking capital flows

We offer a model of financial intermediaries as safe-asset providers in an international context. Investors from countries exposed to expropriation risk seek to invest in safe-haven countries in order to satisfy a demand for safety. Intermediaries compete for such cheap funding by carving out safe claims, which requires demandable debt. While these safety-seeking inflows allow developed countries to lower their funding cost and expand investment, risk-intolerant investors achieve safety by withdrawing even under minimal residual risk. As a result, safety-seeking inflows into developed countries not only reallocate but also create risk. Early liquidation inefficiently diverts scarce resources from productive uses, so a domestic planner wishes to contain the scale of safety-seeking inflows. A macroprudential regulator imposes a Pigouvian tax on safety-seeking inflows.

Debt versus Equity in Liquidity Provision

We propose a unified framework to compare and quantify liquidity provision by debt-issuing banks and equity-issuing mutual funds. We show that both types of financial intermediaries provide liquidity by insuring against idiosyncratic liquidity risks. However, they are subject to distinct constraints depending on the contractual form of their liabilities. Banks issue demandable debt, which exposes them to the possibility of panic runs, whereas funds issue demandable equity, which leads to fundamentals-driven outflows. Based on our theoretical framework, we develop the first empirical measure of liquidity provision that can be generally applied across demandable-debt- and demandable-equity-issuing financial institutions: the Liquidity Provision Index (LPI). We find that a dollar invested in bond mutual funds provides 4.8 cents of liquidity, which is economically significant at one-quarter of the liquidity provided by uninsured bank deposits at the end of 2017. The gap between bank and fund liquidity provision has continuously narrowed over time, suggesting a migration of liquidity provision away from the deposit-taking banking sector to equity-funded non-banks. We find Quantitative Easing and post-crisis liquidity regulation to be contributing factors for this trend. Finally, we exploit the 2016 Money Market Reform, in which institutional prime Money Market Funds (MMF) switched from a fixed to a floating share value, to corroborate the effect of contractual forms on liquidity provision.

Measuring the Performance of Banks: Theory, Practice, Evidence, and Some Policy Implications

The unique capital structure of commercial banking – funding production with demandable debt that participates in the economy’s payments system – affects various aspects of banking. It shapes banks’ comparative advantage in providing financial products and services to informationally opaque customers, their ability to diversify credit and liquidity risk, and how they are regulated, including the need to obtain a charter to operate and explicit and implicit federal guarantees of bank liabilities to reduce the probability of bank runs. These aspects of banking affect a bank’s choice of risk vs. expected return, which, in turn, affects bank performance. Banks have an incentive to reduce risk to protect the valuable charter from episodes of financial distress and they also have an incentive to increase risk to exploit the cost-of-funds subsidy of mispriced deposit insurance. These are contrasting incentives tied to bank size. Measuring the performance of banks and its relationship to size requires untangling cost and profit from decisions about risk versus expected-return because both cost and profit are functions of endogenous risk-taking.This chapter gives an overview of two general empirical approaches to measuring bank performance and discusses some of the applications of these approaches found in the literature. One application explains how better diversification available at a larger scale of operations generates scale economies that are obscured by higher levels of risk-taking. Studies of banking cost that ignore endogenous risk-taking find little evidence of scale economies at the largest banks while those that control for this risk-taking find large scale economies at the largest banks – evidence with important implications for regulation.

Cheap But Flighty: How Global Imbalances Create Financial Fragility

We analyze how a wealth shift to emerging countries may lead to instability in developed countries. Investors exposed to expropriation risk are willing to pay a safety premium to invest in countries with good property rights. Domestic intermediaries compete for such cheap funding by carving out safe claims, which requires demandable debt. While foreign inflows allow countries to expand their domestic credit, risk-intolerant foreign investors withdraw even under minimal uncertainty. We show that more foreign funding causes larger and more frequent runs. Beyond some scale, even risk-tolerant domestic investors are induced to withdraw to avoid dilution. As excess liquidation causes social losses, a domestic planner may seek prudential measures on the scale of foreign inflows.

Delegated Monitoring and Moral Hazard in Underdeveloped Credit Markets

This paper originates from the current move to individual-based lending systems by many microfinance institutions and the fear that this move will lead to a decrease in access to credit for the poor. More specifically, the paper examines how an individual-based lending scheme can be devised such that moral hazard issues can be addressed, even when straight forward individual lending is unable to do so. We show that the moral hazard problem can be solved if microfinance institutions hire informal lenders to monitor the borrowers. In addition, we show that by offering the informal lender a demandable debt contract a simple incentive scheme could be obtained that induces the informal lender to collect the necessary information, and to truthfully reveal this information.

What's Different About Banks? Depositor Discipline and Active Monitoring

In this paper we provide an empirical link from Fama (1985) and James' (1987) observation that banks are special to Diamond and Rajan's (2001) model of the banking firm as an active monitor financed with demandable debt. Drawing on a sample of 423 bank loan announcements made during 1988-1996, we document that borrower abnormal announcement returns are positively related to proxies for the bank's ability (or incentives) to monitor. Using a sample of 4,534 bank loans originated during 1987-2003, we find that an index of superior monitoring ability based on these factors is positively related to the loan yield spreads paid by bank borrowers. These two findings are evidence that 1) bank borrowers pay a premium for bank monitoring services; and 2) the excess returns associated with bank loan announcements are in fact a reflection of the monitoring benefits generated by the bank. The proxies that are related to both abnormal announcement returns and borrower spreads are 1) the ratio of the bank's uninsured deposits to total loans, 2) a risk-adjusted measure of recovered charge offs, and 3) the bank's relative capital ratio. Thus, our results reveal a heretofore empirically undocumented benefit of uninsured demand deposits: they appear to improve the bank's incentives to monitor borrowers. The first two proxies are strikingly consistent with the theory of banking laid out in Diamond and Rajan (2001). As predicted by Diamond and Rajan (2001), our empirical results indicate that, for the best bank monitors, monitoring skill and fragile (uninsured) demand deposits co-exist.

Comment on Demandable Debt as a Means of Payment: Banknotes versus Checks

Comment on Demandable Debt as a Means of Payment: Banknotes versus Checks

Comment on Demandable Debt as a Means of Payment: Banknotes versus Checks

Comment on Demandable Debt as a Means of Payment: Banknotes versus Checks

Demandable Debts as a Means of Payment: Banknotes versus Checks

We examine whether transactable forms of privately issued, demandable debt are better used as or The distinction between the two is that a check must be redeemed by the issuing bank with each use whereas a banknote can circulate. We find that the answer to the question depends on the cost of early redemption. If this cost is small, banknotes will not circulate so the question is moot. If this cost is large, incentive problems may prevent the circulation of banknotes. For intermediate values of the early redemption cost, banknotes will be preferred over checks.

Efficient investment and financial intermediation

Insider trading causes uninformed agents to reduce their investments in assets that are most susceptible to it. This problem may be mitigated by forming a financial intermediary that issues securities with different sensitivity to inside information. In particular, the uninformed agents desire the intermediary's demand debt while the informed agents choose its equity. By separating the uninformed agents' financial payoffs from the intermediary's investment decisions, the intermediary can pursue more efficient investments and achieve allocations that are superior to those of the market.

The Transmission Process and the Relative Effectiveness of Monetary and Fiscal Policy in a Two-Sector Neoclassical Model

In traditional Keynesian income-expenditure modelsl the assets included appear to be four: money (government demand debt and bank demand deposits), long-term government bonds, private debts, and physical capital. Although there are four assets in these models, there are only two yields: the rate of return on money, which is institutionally set at zero, and the rate of interest, which is common to the other three assets and is usually identified with the rate of interest on long-term government bonds. This reflects the underlying assumption of the Keynesian theory that capital, long-term government bonds, and private debts are perfect substitutes for one another in wealthowners' portfolios. As a result of this assumption there is only one yield differential to explain, or, alternatively, only one portfolio choice-that between money and earning assets. This assumption may also be responsible for the failure of Keynesian models to relate explicitly the stock of real capital to the flow of investment spending [38, p. 106] . One line of development subsequent to Keynes' theory of the demand for money has been the disaggregation of assets other than money and the elaboration of liquidity preference theory into a general theory of the relative prices of assets of different types. In recent years this has led to the formulation of a general theory of asset holdings in which the quantity of each asset held is determined by the rates

Inflation as a Post-War Problem

being created. Even if it is believed that the war will come to a quick and successful conclusion, the character of the public debt should be carefully scrutinized. Approximately one-half of the Treasury's promises to pay are of a short-term or demand nature. With such a large proportion of the debt unfunded, the fiscal authorities must constantly be on their toes to keep their ever maturing obligations turning over -a task which will be difficult only if the government persists in a short-range program to meet its future financial requirements. The emphasis on short-term debt is even more pronounced during the present global conflict than was the case during World War I. As of June 30, 1920, the close of the fiscal year during which the public debt was at its peak, the federal government was confronted with obligations of which only one-third were short term.' The makeup of the Treasury's commitments at the present time and those resulting from World War I is presented in Table i. Although the government includes United States Savings among its Bonds or long-term debt, we incorporate them in Short-term and demand debt. The very nature of these obligations and the type of purchaser dictate such a procedure. By means of these obligations the Treasury, since 1935, has been conducting an increasingly vigorous campaign to tap the savings and income of individual investors, particularly small investors. Notwithstanding the fact that these securities do not mature for ten or twelve years, purchasers are given the option of converting them into cash either sixty days or six months following the date of their sale, depending upon the type of savings bond sold. The Series E Bond is redeemable at any time sixty days after the issue date; the Series F and C, six months thereafter. The government's objective in urging heavy public subscription to these special issues, especially since the beginning of the war, has been to reduce the growing volume of purchasing power in the hands of consumers and so in part to offset its disparity with the dwindling supply of consumers' goods. The national campaign to accomplish this objective has achieved some success with monthly sales at times exceeding one billion dollars.